An Individual Savings Account (ISA) is a tax-free savings account available in the UK to residents over the age of 16 (cash ISAs) or 18 (stocks and shares ISAs). Savers are allowed to invest 10,680GBP in a single tax year, either in stocks and shares, or a mixture of stocks and shares and cash. As with most things in life, there are pros and cons attendant on investing in an ISA.
ISAs are easy to open and administer. Anybody – even someone with little or no financial knowledge – can open and run an ISA, without the need for specialised advice. Terms and conditions – particularly for cash ISAs – are usually easy to understand.
Higher interest rates
Typically, ISAs carry a higher rate of interest than regular savings accounts. Sometimes, account providers offer a special interest rate for the first year, or another form of interest incentive to attract investment, such as a guaranteed rate if you lock in your money for a fixed term.
Stocks and shares ISAs are free from Capital Gains Tax (CGT), while interest on cash ISAs is paid tax free. When you withdraw money from ISAs, there is still no tax to pay, so ISAs are a tax efficient vehicle for your savings. In addition, you may be able to link shares you already own to an ISA, which makes for even greater tax efficiency.
Savings invested in an ISA are easily accessible at any time, without penalties. However, some accounts may require interest prior to withdrawal. In that case, penalties may apply if you require instant access.
Unsuitable for short term investment
Stocks and shares ISAs in particular are unsuitable for short term investment, or for investing small amounts of money. Where cash ISAs are concerned, if you only invest a small amount of money, the tax savings on the interest are hardly worth bothering with.
Also, if you need money in an emergency, you may not be able to replace that money later if you have reached your limit for the tax year. For example, if you invest the full 5,340 GBP in April, but need to withdraw half of it in November, you cannot replace it later, even if you have money to spare, as you have already invested your full allowance.
If you don’t use your full ISA allowance in one tax year, you can’t roll it over until the next tax year and add it to that allowance. It’s lost forever. You can only subscribe to one cash ISA or one stocks and shares ISA in a tax year, even if you don’t use all your allowance. This means if you discover you’ve placed your ISA with the wrong provider, you can’t transfer it until the new tax year.
Difficult to transfer
While theoretically anyone can change their ISA to another provider, in practice it’s not so straightforward. Some providers may not accept transfers from previous years, and if they do, the interest rates may be lower than those for ISAs which only accept new money. Furthermore, if you decide you want to transfer your stocks and shares ISA balance into a cash ISA, you can’t do that either.
It may also be difficult to move an existing ISA to a new provider, although in theory you should be able to do that. However, the existing provider or the receiving bank may place conditions on moving your ISA.
For anyone who pays income tax, an ISA should be the first savings choice, because interest is tax free. However, ISAs may not be the most suitable homes for those who only have small amounts to save, or for people who don’t pay Income Tax. If you’re unsure what’s the best solution in your case, seek the advice of an Independent Financial Adviser.